The boom-bust cycle: where are we now?
The credit crunch of August-September 2007 has disturbed the economic equilibrium - and may continue for a while yet. Debates about illiquidity or insolvency abound, but are we really facing a swing from boom to bust?
The underlying UK economy is strong, but we now have corporate transactions stalling through lack of funding, hedge fund failures, a sub-prime lender in administration and the Northern Rock bailout. What many considered a strange US phenomenon (had many people heard of sub-prime before this summer?) has become a real domestic issue. No wonder business and consumer sentiment is waning:
- the ICAEW UK Business Confidence Monitor (BCM) has moderated in Q3 2007 from a Q2 peak of +11.5 to a relatively weak +4.8;
- the BDO Optimism Index shows a sharp fall in August, from 101.9 to 101.2, confirming the impact of the US sub-prime crisis on UK businesses. This drop takes the Index to its lowest score since November 2005 and whilst business optimism has been decreasing slowly since July 2006, it appears that the impact of the turbulent financial markets has accelerated this trend; and
- the Nationwide Consumer Confidence Index fell back in August reflecting the impact of five interest rate rises over the past year. The main Index fell by two points, but it was not alone. All indices fell in August, the first time since December 2006 that all four measures of confidence showed a downturn in the same month.
For a reminder of how the credit crunch derived from the US sub-prime contagion via risk reappraisal amongst lenders and hedge funds, how CDOs, CLOs and SIV-lites were ideal vectors to spread the disease around the world, and the impact on bank lending, read "While you were away - fear and loathing in the markets" from The Times.
Other recent indications of the state and direction of the economy are:
- US business bankruptcies are on the rise, reports Bob Eisenbach, quoting Euler Hermes, who continued to forecast a small rise in the UK. After we reported Euler's November '06 forecast in a previous post, Geoff Swire commented when the UK's June insolvency figures became available that the forecast had been pessimistic. I suspect it was a timing issue and that corporate insolvency statistics in Q3 will rise in the UK, albeit by less than in the US.
- The world has changed dramatically: Germany’s Chamber of Industry has been flooded with distress calls from family Mittlestand firms unable to roll over credit lines and in Canada and Australia, junior mining finance has dried up almost entirely, according to Ambrose Evans-Pritchard on his Telegraph blog post "Brace yourself for the insolvency crunch".
- If the liquidity crisis continues it will will become an insolvency crisis and the banking industry will be hardest hit, according to Panmure Gordon.
- Insolvency firms are likely to be busy dismantling failed investment vehicles, with the most likely suspects being the quantitative hedge funds and funds focused on CDOs that have fallen foul of market conditions, writes Antonia Rawlinson "Uncertain times call for certain measures" in The Lawyer.
- "The M&A boom is over and law firms must adapt" agrees James Rossiter in The Times - restructuring is now the hottest game in town.
So what does all this mean? Yes the capital markets are in turmoil, banks are lending much more cautiously and some high risk investment vehicles are failing, but essentially this is only a liquidity problem. Its effect though is that stressed businesses will no longer be able to borrow their way out of trouble as they have become hard-wired to do over the last 3 years.
Crisis cash management and operational and corporate restructuring will come back into vogue as refinancing becomes passé. Only if stressed businesses fail to seek appropriate and timely assistance will the business insolvency statistics really start to rise.
Date: 15th September, 2007
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